The present invention is related generally to financing and, more particularly, to financing through the issuance of debt obligations.
Municipalities may issue debt instruments that are tax-exempt if the proceeds of the offering are to be used by the municipality to fund projects related to their day-to-day activities or for specific projects that they might be undertaking (usually pertaining to the development of local infrastructure such as roads, sewerage, hospitals, etc.). Debt instruments may be issued as fixed or variable rate. One type of variable rate tax-exempt debt obligation that municipalities sometimes issue is tax-exempt variable rate demand obligations (VRDOs). VRDOs are bonds (VRDBs) or notes (VRDNs) which bear interest at a variable, or floating, rate established at specified intervals, e.g., daily, weekly or annually. VRDOs contain a put option permitting the holder to tender the bond or note for purchase when a new interest rate is established.
Since borrowing costs are, in part, a function of the credit quality of the borrower, municipalities typically seek to secure the highest rating for their issued debt instruments. Moreover, when issuing VRDOs, municipalities typically seek to issue VDROs that are attractive to money market funds. Money market funds are subject to rule 2(a)(7) under the Investment Company Act of 1940. In order for a municipality's bonds, including VRDBs, to satisfy rule 2(a)(7) such that they may be held by a money market fund, the issuer of the bonds must have a very high long-term credit rating. Issuers who do not have a very high long-term credit rating on their own could traditionally enhance their credit rating by either (i) obtaining bond insurance or some other guaranty or (ii) obtaining a letter of credit.
Many tax-exempt issuers are finding it increasingly difficult to find traditional credit enhancement. Due to rating agency concerns and self-imposed single name risk exposure limits, many traditional enhancers are not able to provide additional enhancements to these issuers on a cost effective basis.
Obtaining a letter of credit (LOC) is also problematic for many issuers. Several traditional LOC providers have exited the market due to profitability concerns or due to rating downgrades below the required rating category. LOCs also expose the issuer to put risk in the event the LOCs ratings decline or if the facility is not renewed. Because a typical LOC has a term of 1-3 years, the rollover/put risk makes it difficult to create core variable rate funding.
Consequently, there exists a need for alternative mechanisms by which a prospective issuer of municipal bonds can enhance the credit rating of its issues.